How a Problem Led to a 120% Return

When investors think outsized investment returns, they frequently think technology.

I understand the connection since the sector has historically produced the highest-return investments. In fact, I wrote about a high-return technology investment last week. I'm referring to my investment in Netflix (NASDAQ: NFLX) for the $100K Portfolio.

In short, I first recommended Netflix in December 2011, when its shares were trading at $71. Today, they trade north of $220. 

Netflix has been an exceptional investment for the $100K Portfolio. But it’s not necessarily a great investment for all investors, particularly for conservative income-and-yield investors, such as those who follow the High Yield Wealth portfolio. Of course, there’s the obvious reason: Netflix doesn't pay a dividend.

But this doesn't mean the basic investment strategy – the reason for investing in Netflix – doesn't cross all investor constituencies or all types of stocks. They do, and I've applied the same rationale I used to buy Netflix to more conservative income investments in High Yield Wealth. 

The strategy is to invest in problems – one of my favorite investment strategies – along with dividend growth (which I've discussed in detail in the past).  

I like problems because problems set up an investment for exceptional returns. Problems weigh on the share price, thus offering a lower cost basis and the opportunity to benefit from the price appreciation that subsequently occurs once progress is made on resolving the problem. 

Problems don't even need to be real; they can be perceived. 

This was the situation with Omega Healthcare Investors (NYSE: OHI), the long-term facilities care REIT I recommended to High Yield Wealth subscribers around the same time I recommended Netflix. 

Back in December 2011, Omega's share price was depressed on a perceived serious problem.

At the time, investors were fearful that skilled-nursing-care providers – Omega's tenants – would be hurt after the federal government announced an 11% cut in Medicare and Medicaid reimbursements.

The primary concern (and hence the “problem”) was that some of Omega's tenants wouldn't have enough cash to pay their rent due to the decrease in reimbursements. There was historical precedent to back up this fear. In the late 1990s, similar cuts forced many long-term care operators to fold, thus hurting the REITs that provided the facilities. 

So there was the problem. 

But it really wasn't a problem. This was 2011, not 1999. Omega was well-positioned to deal with any potential government cutbacks. It operated (and operates) a geographically diverse real estate portfolio, which matters because different states have different mixes of private and public support.

In addition, its portfolio was (and is) diversified across many operators. No one operator occupied more than 10% of Omega's properties. At the same time, management had publicly stated it foresaw no impact to its funds from operation (source of dividends).  

Nevertheless, investor perception depressed Omega's share price, thus offering an enticing opportunity. When I recommended Omega, its shares were trading below $18. They were also yielding 9%. Omega provided the perfect storm – a depressed entry price coupled with a sustainable high-income stream that had been annually increased since 2004. 

Fast forward to today, and we find the problem was indeed perceived: Omega continues to grow its funds from operations and its payout to investors. The dividend has been increased five of the past six quarters, and now yields 10.3% on my initial recommendation price. 

As for Omega's share price, it has moved higher with the dividend payout. In fact, it has doubled over the past 18 months. When dividends and price appreciation are factored, Omega has produced a 120% total return. 

I've used this strategy of “problem investing” repeatedly since starting High Yield Wealth. Many of these “problem” investments have subsequently proven to be exceptionally profitable.

The take-home message is don't shrink from problems. Seek them out. When the problems are placed in their proper perspective, profitable opportunities arise.